What is a DTI and is it important?

By: Dan Murtaugh, Vice President, Sandy Spring Mortgage

If you are interested in purchasing a home, your debt-to-income ratio (DTI) is an important number for you to know. Your DTI measures how much debt you have compared to your overall income, so the lower the number, the better. To calculate your DTI, your bank or lender will add all of your monthly liabilities, and divide it by your gross monthly income.

Here is an example:

  • Gross Monthly income: $10,000
  • Monthly Liabilities: (Debt): $4,000 (including new proposed mortgage)
  • Monthly DTI = 40%

Your DTI ratio is comprised of two separate figures: a “back-end” ratio and a “front-end” ratio.

The above example is a back-end ratio, which encompasses your new mortgage payment, taxes and insurance, and all of your monthly expenses that would appear on a credit report (e.g. credit card balances, car payments, student loans); this figure is then divided by your gross monthly income. In contrast, your “front-end” ratio is just the ratio of your new mortgage payment, taxes and insurance, compared to your annual income. If your total mortgage payment is $2,500 and other monthly debts total $1,500, your “front-end” ratio would be 15%, therefore assigning a 15/40 DTI.

In recent years, revised policies relating to the Qualified Mortgage rule (QM) have affected the necessary ratio percentages needed to obtain a mortgage, for both the front and back end ratios. However, it’s important to remember that your DTI and credit score are the most important factors in determining if you can afford a particular mortgage payment and a pre-approval through a reputable lender will help you determine this up front.

As always, it’s best to discuss your individual financial picture with a trusted financial professional and to explore all of the options available. Working with an experienced lender will ensure that you make an informed financing decision when achieving your home ownership goals.

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